2018: The (Not So) Exciting Year!

Weakness prevailed across global markets

What seemed like a strong start to 2018 was transformed by weakness in global equities as investors grappled with issues relating to slowing global growth, strengthening USD, currency crises in some emerging markets, geopolitical tensions, and to top it all – escalating trade tensions between the US and China.

Singapore equities mirrored global equity weakness

The Singapore market could not escape the weakness in global equity markets. A strong share price performance from the banking sector and the addition of Venture Corp (SGX:V03) to the STI propelled it to a record high from 2007 to early January. But concerns over higher-than-expected rises in US interest rates leading to a stronger USD and hence weaker SGD, along with the potential impact from the trade war between the US and China, dragged the STI lower.

While investors were coming to terms with the likely impact from the trade war and slower economic growth in Singapore, property cooling measures implemented by the Government caught the market by surprise. Investors are now staring at slower loan growth for banks and weaker earnings for property developers, which will likely have a trickledown effect on private consumption.

In 2018, while institutional investors, who largely focus on liquid mid-to large-cap names and more specifically index stocks, were cumulative net sellers in the Singapore market, we saw strong cumulative buying by retail investors. Retail investors bought SGD1.3bn worth of stocks vs SGD3.6bn worth of Singapore stocks sold by institutional investors in 2018. Despite being overall net sellers in the Singapore market, institutional investors were small net buyers of banks, consumer staples and industrials. See also SGX Market Fund Flow Overview.

2019: What To Expect

Global economic slowdown, now evident in the US as well

Based on OECD leading indicators, signs of slowdown in Japan and the Eurozone were visible at the start of 2018. While US economic growth was strong in 2018, some of the forces supporting its growth are expected to fade going forward. Based on Bloomberg consensus estimates, US economic growth is expected to slow to 2.6% in 2019 and 1.9% in 2020, from 2.9% in 2018.

Trade tension between the US and China, which remains an uncertainty heading into 2019, could have a significant impact on the magnitude of slowdown in US economic growth. While the likely inversion of the US yield curve is indicating rising risk of recession in the US sometime in the future, we believe that this isn’t the base case scenario.

We believe equity prices relate more to improving or worsening economic indicators, rather than just good or bad economic indicators. With global economic slowdown in the background, which is already causing a lot of nervousness and apprehension amongst investors, we believe equity markets will continue to remain fragile. Investor sentiment could see a much wider swing in 2019, assuming the market volatility persists.

We expect Singapore to register positive growth in 2019. However, GDP growth will most likely drop to 2.8% in 2019, a slowdown from 3.2% expected this year. We expect weaker growth in exports to be mitigated by positive domestic demand, especially private consumption and investment.

Slower manufacturing and NODX growth for Singapore

The subdued GDP growth for Singapore is expected to come on the back of a marked slowdown in manufacturing growth, which is expected to moderate to 3.8% in 2019 from an expected 7.3% in 2018. Sub-segments, such as semiconductor and precision engineering industries, are expected to turn weaker in 2019. This is a reflection of a global electronics down cycle from the high growth seen in 2017.

We also expect exports to moderate in 2019, as the dimmer outlook for advanced and regional economies should translate into a more modest external environment for Singapore. While global demand will still expand, the rate of growth in 2019 will be less assertive. We note that historically, STI’s earnings growth has had a positive correlation to Singapore’s non-oil domestic exports (NODX).

Rising interest rates – but less than earlier expected

During September’s Federal Open Market Committee (FOMC) meeting, the US Federal Reserve (US Fed) left its federal funds rate (FFR) projections unchanged, ie the FOMC continued to project one more rate hike in 2018, and three in 2019. However, the prospects for slowing global economic growth, fading US fiscal stimulus, and volatile financial markets all point to more caution.

We believe there will be room for greater flexibility on the timing of any tightening, with delays being a modest possibility. We believe the US Fed could lift rates once during next week's FOMC meeting and indicate a moderation in further rate hikes through a revised "dot plot" release. Markets have already started pricing in a single quarter rate hike between Dec 2018 and Dec 2019 vs the September expectation of two quarter rate hikes.

Historically, Singapore’s 3-month SIBOR has mirrored the moves in the US FFR with some lag. While slowing of the US FFR hike should be good news for markets, we believe it could moderate the expansion in Singapore banks’ net interest margin during 2019.

Modest gains in the SGD could support local equity market

If rate hike expectation is a driving force for the USD, that argument seems to be fading of late. While there was significant expectations being built up for a sustained tightening by the Fed when the accommodative word was left out of the communiqué in the September FOMC, market pricing, however, is gradually switching towards some form of lethargy in arguing for sustained tightening of monetary policy by the Fed. We see less room for fresh USD-positive surprises as 2018 rate hikes have put the FFR closer to its terminal value.

We believe there will be room for greater flexibility with regards to the timing of any tightening, with delays a modest possibility. A mechanical approach to tightening may not be well-suited to meet upcoming challenges beyond 2018. The fact that Eurodollar futures are repricing rate hikes by the Fed (Dec 2018 vs Dec 2019 contracts) suggests that from an initial two quarter rate hikes, the market is repricing it to a single quarter hike.

That said, for the DXY Index itself, lower highs are likely to be the next permanent feature for the currency. From its heydays of peaking north of 100, the index is showing lethargy – even being in the 90-95 range is becoming a struggle of late. The big question is whether there are fresh legs for the currency to move further north. We believe this is becoming extremely difficult.

Our belief that a tightening monetary policy by the Fed will drive the USD higher is gradually fading, and this in turn could provide the well-needed reprieve for emerging market (EM) asset classes if the USD shows an inclination to retrace or even to stabilise at the low 90s in its index. Until then, the low highs for the USD are a more likely scenario going forward.

Our SGD view is premised upon a broadly weaker USD in the year ahead, counterbalanced by lower propensity for further Monetary Authority of Singapore (MAS) tightening alongside continued volatility on the global trade front. However, we expect gains in the SGD to be less stellar than other Asia ex-Japan peers.

Firstly, the regional safe haven status of the currency would imply lower beta of the SGD (ie less sensitive to currency drivers). This would put it in a position to reap a lower upside during a recovery, relative to higher beta peers around the region.

Secondly, we also hold a relatively cautious view on the trade war, where Singapore is heavily exposed on this front.

Given the above, we eye a lower propensity for further MAS tightening in its April and October policy reviews, with the central bank likely to take into account non-inflationary factors in deciding the SGD nominal effective exchange rate (S$NEER) policy.

Our economics team is currently eyeing another round of S$NEER tightening in Apr 2019, before standing pat in the Oct 2019 review. Interestingly, the 90-day truce between the US and China will end right before the MAS Apr 2019 decision, implying any decision on its SGD NEER policy will be heavily influenced by the outcome of the trade deal.

Since 2017, we have witnessed a strong correlation between the strength of the SGD against the USD and the STI’s performance. In 2018, the STI’s decline coincided with a weakening of the SGD, as investors booked gains registered in Singapore stocks during 2017. Although it is far from being the only reason to invest in any market, we believe expectations of more moderate gains in the SGD could get investors interested again in quality Singapore-listed equities.

Uncertainty over trade tensions

Singapore’s economic growth is highly dependent on exports, as evident from the fact that its total trade is more than two times the country’s GDP. An escalating trade war between China and the US would have a direct impact on Singapore’s economy and in all likelihood, STI earnings growth as well.

A prolonged trade war will hurt economic growth and result in further cuts to corporate earnings, which could be negative for the Singapore market.

We foresee any indications of easing trade tensions to translate into a relief rally for the Singapore market – similar to the one witnessed after a 90-day moratorium on incremental tariffs was announced post the Donald Trump-Xi Jinping trade talks at the G-20 meeting. However, such a rally would be short-lived if a resolution to the trade war is not certain.

Volatile equity markets

The level of anxiety in equity markets suggests that investors may be especially likely to overreact to bad news, creating an especially unstable investing environment. We believe market volatility is a 2018 theme that is likely to persist in 2019.

While we expect volatility to remain elevated, it does not necessarily mean that long-term investors should abandon risk assets. We view this as an opportunity to buy into quality defensive stocks that offer resilient growth in earnings and dividends, while the macroeconomic environment remains uncertain.

Singapore’s Government could incur a budget deficit in 2019

In 2019, we envisage higher spending on social and economic development to provide a cushion amid the more uncertain external environment. On the social front, we expect the Government to commit to more spending on infrastructure, healthcare, and social support.

On economic development, public sector project payouts are expected to be on track. As a result, we expect the Government to incur a slight deficit of -0.5% of GDP in 2019.

The year will also see the carbon tax at SGD5 per tonne of emissions take effect, which should add roughly SGD1bn to Government coffers during the first five years. However, the revenue collected by end-2019 will likely be offset by higher GST rebates to eligible households, as well as through schemes like the Productivity Grant and Energy Efficiency Fund.

There is also a distant possibility of an early election in late 2019. The next parliamentary general election must be held before 15 Jan 2021. However, Singapore has a history of early elections.

In addition, considering the GST hike to 9% from 7% that is to be implemented sometime between 2021 and 2025, there is a greater chance that political uncertainty would be dealt with first. This could mean that the Government’s budget planning for next year would be skewed more towards addressing voters’ complaints, with greater emphasis on financial support measures.

Market Valuation

Implications from slowing economic growth.

The STI has declined by 12% in USD terms YTD in line with slowing economic growth, the weakening SGD against the USD, and cut in corporate earnings. As seen in Figure 38 in the PDF report attached, Singapore’s stock index returns follow the country’s nominal and real GDP growth closely. We believe it will be tough for the STI to generate strong positive returns as our economics team is forecasting a slowdown in GDP growth to extend into 2019 and 2020.

STI target of 3,300 for end-2019.

We use a top-down method to derive our STI index target, based on a P/E multiple on 2019 forecast EPS. STI’s 12.7x 1-year forward P/E sits at its -1SD band, which has only been breached twice since the global financial crisis – each time, the market witnessed a sharp rebound. With expectations of a slowdown in GDP growth, we believe a strong P/E multiple expansion will be difficult to pencil in.

We value the STI based on average forward P/E of 13x, which is slightly above where the index is trading right now. Applying this to 2019 EPS estimate, we derive an index target of 3,300 for end-2019 (+7.4% from 10 Dec 2018 closing price).

Including a 4.2% dividend yield for the market, this implies a total shareholder return of 11.6% in 2019.

Stock analysis research and articles on this site are for the purpose of information sharing and do not serve as recommendation of any transactions. You will need to make your own independent judgment regarding the analysis. Source of the report is credited at the end of article whenever reference is made.